Audit risk assessment

​​During the engagement team meeting for the audit of the 2024 financial statements of Lima Ltd., the engagement partner emphasised to his audit team that special attention needs to be focused on significant risks.

Required:

(i) Explain the term “significant risks”.

(ii) Describe factors that the auditors could consider to determine whether a risk is significant risk or non-significant. 

​​International Standard on Auditing (ISA) 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment”, gives extensive guidance to auditors about audit risk assessment. 

​​According to International Standards on Auditing (ISA) 315, “Identifying and Assessing the Risks of Material Misstatement”, the auditor should use assertions for classes of transactions, account balances and presentation and disclosure in sufficient detail to form a basis for the assessment of risk of material misstatements. 

​​Auditors are required to perform risk assessment procedures to provide the basis for identification and assessment of risks of material misstatement at the financial statement assertion levels. 

​​Nguo Nzuri Company is a local manufacturer of office wear for both ladies and men. After the COVID-19 pandemic, the market of this line of clothes was adversely affected. Prior to the pandemic, the company had taken on a big loan from its bankers and invested in new manufacturing equipment and a fleet of delivery vans. The bank has written to the managing director of Nguo Nzuri Company threatening to petition for the liquidation of the company due to its difficulty in servicing the loan. 

(i) In the context of International Standard on Auditing (ISA 530) – Audit Sampling, use relevant examples to distinguish between “sampling risk” and “non-sampling risk”, citing relevant examples.

​​Auditors use assertions in assessing risks by considering potential misstatements that might occur and thus designing audit procedures that respond to each risk. 

​​Elimu Yetu Trust is a charitable institution that sponsors needy students to seek tertiary education in Europe. The organisation raises finances from cash donations at annual fund-raising events, telephone and online appeals from well-wishers. Elimu Yetu Trust has employed a part-time bookkeeper since it is still at an early formative stage and the trustees cannot afford to hire a qualified accountant. Following a recent review of the Finance Act, charitable institutions will be subjected to new audit and accounting regulations. Due to this, your firm has been appointed as first-time auditors of Elimu Yetu Trust. You have been informed by the trustees of Elimu Yetu Trust that the unaudited financial statements for the year have been prepared by a volunteer who is a recently retired qualified accountant.

Required:
(i) Describe TWO examples of each of the following risks associated with the audit of Elimu Yetu:

• Inherent risks.
• Control risks.
• Detection risks.

(ii) Propose FOUR audit tests that you could perform on income from fund raising events.

(iii) Evaluate THREE substantive audit tests that you might undertake to verify the expenditure during the fund raising events.

​​International Standard on Auditing (ISA): “Going Concern”, deals with the auditor’s responsibilities in the audit of financial statements relating to going concern and the implications for the auditor’s report. 

​​Jenga Ltd. operates from fifteen separate depots providing plant and machinery hire service throughout the country.

The company offers hire services of a wide variety of tools and equipment to:

1. Builders and corporate customers on credit.

2. Members of the public on advance payment terms, including payment by cash.

In addition to the revenue generated from the hire of plant and machinery, the company also generates income from the sale of damaged or aged machinery and the hire of accessories and safety equipment.

Required:
(i) Explain the term "inherent risk".

(ii) Evaluate three factors that could suggest that there might be a high inherent risk applying to plant and machinery income as reported in the financial statement of Jenga Ltd

​​Explain the meaning of the term “inherent risk”.

​State with reasons five factors that would affect the initial assessment of inherent risk at the financial statement level. ​

​ ​​Your firm has diverse clientele from various sectors. You have been allocated the task of planning for an audit of Tamuko Creameries Ltd., a company that manufactures a variety of milk products. This will be the second year your firm is providing audit services to Tamuko Creameries Ltd.

The following information is available:
1. The company's finance manager has informed you that the company has recorded fast growth. The company's financial accounting systems have been changing rapidly and appropriate control systems are proving challenging to maintain. Additional services in terms of review and implementation of control systems have been requested.

2. The company has recently established an internal audit unit and the finance manager wants you to ensure that external audit work is limited by using this unit.

3. The company plans to produce and market a new brand of yoghurt specifically for export to neighbouring countries. This has not been approved by the Export Licencing Agency.

4. The granting of the export licence is dependent on the financial stability of the company.

5. The finance manager has indicated that the company will be required to provide a report to the Export Licencing Agency on cash flow forecasts for the upcoming financial year to support licence application

Required:
As part of your risk assessment procedures for the audit of Tamuko Creameries Ltd., evaluate five items to be considered when providing services to this client.

​​International Standard on Auditing (ISA) 315, "Identifying and Assessing the Risks of Material Misstatement through

​​​​​Examine six factors that might be taken into consideration by an audit engagement team when determining the extent of tests of control to be performed.

​​Assess five potential indicators that a client's company is not a going concern.

​​Distinguish between "tolerable error" and "expected error".

​​(i) Explain the term "inherent risk". 

​​In the context of International Standard on Auditing (ISA) 560 - Subsequent Events:

(i) Distinguish between "adjusting events" and "non-adjusting events" giving an example in each case.

(ii) Analyse the relationship between "going concern" and "non-adjusting event".

​​ Examine the importance of materiality assessment to an auditor.

​​Discuss four circumstances which might cause an auditor to change his risk assessment of a client company.

​​Your firm has been appointed the auditor for Musoni Ltd., a company that distributes computer equipment. During the audit, the following matters came to your attention:

1. The depreciation rates had been reviewed and adjusted resulting in an increase in asset lives and a reduction in depreciation amounts.
2. Stock take across all the warehouses could not be undertaken due to lack of staff.
3. One of the warehouses caught fire and goods worth Sh.50 million got damaged. A claim had been lodged with the insurance company but the incident was still under investigation. The amount had however been included in the financial statements as expected income.
4. Bank reconciliation had not been completed even though there were material balances.

Required:

Describe four audit risks arising from the issues above and the proposed auditor's response.

​​ Examine six factors that might influence inherent risk at the organisational level.

​​Explain the following terms as used in auditing:

(i) Audit risk.

(ii) Inherent risk.

(iii) Control risk.

(iv) Attest engagement.

(v) Direct reporting engagement.

​​(i) Explain the meaning of the term "going concern".

(ii) State eight factors that might indicate doubt in the ability of an entity to continue as a going concern. 

​​My-family Car Hire Limited has a large fleet of cars for hire. The firm operates from twelve separate depots providing national car hire services around the country. It offers car hire services to corporate customers on credit payment terms, including payment by cash.

​​Outline the meaning of the following terms:

(i) Audit risk.

(ii) Inherent risk.

(iii) Control risk.

(iv) Detection risk.